Pawning your portfolio

Wealthy investors are using their stocks and bonds to get large loans

By

IanSalisbury

With loans still hard to come by, wealthy investors are embracing a somewhat surprising and potentially risky strategy: pawning their stocks and bonds.

Using what’s known on Wall Street as “non-purpose securities-based loans,” these investors are using their portfolios as collateral to borrow large amounts—often six figures and up—that can be used for anything from buying a rental property to paying off a hefty tax bill.

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Big brokerages like Morgan Stanley, UBS and Raymond James say the pace of this lending is growing at a much faster rate than its close cousin, margin loans. Those loans allow investors to borrow against the value of their securities in their brokerage accounts, but the proceeds are traditionally reinvested in the market.

Margin loans are frequently available to investors with smaller balances but tend to be more expensive and don’t come with perks like the option to fix rates.

Morgan Stanley estimates that non-purpose loans have been growing “at a double-digit clip” for the past four or five years while margin loans have been flat or down. “In a tight credit market, you can get this money quickly and easily,” says David Kanigan, head of products for Morgan Stanley’s private bank.

That convenience comes at a cost, warn financial advisers. Investors can typically borrow 50% to 95% of the value of the stocks and bonds they pledge, but if the value of those securities falls below a certain level, brokerages often demand investors immediately pay back the loan or pony up additional collateral. While investors may have a few days to respond, if prices drop too quickly their brokerage can even sell out an investor’s positions without permission.

“It could really blow up” if there is another crash or sharp correction, says George Middleton, an independent financial adviser in Vancouver, Wash.

Nevertheless, wealth management firms say that in the wake of the financial crisis wealthy investors are finding it harder to borrow through traditional channels. That is partly because of tighter lending standards, as well as new regulations that have added to the already hefty paperwork.

When clients need a private eye

(1:31)

An advisory firm in Ohio employs a former FBI agent who offers its wealthy clients forensic accounting as well as background checks on domestic help, prospective business partners and potentially risky investments.

For instance, a commercial mortgage on a rental property typically requires copies of rent rolls, leases, tax returns, an appraisal and more, taking several weeks to assemble, says Bill Geis, head of retail lending at Raymond James Bank. Non-purpose loans, by contrast, can typically be completed in a few days requiring little paperwork beyond a credit report and a financial statement. “It’s a simplified process,” he says.

Another big benefit: For wealthier investors, interest rates on non-purpose loans can be attractive compared with alternatives. At UBS, for instance, investors borrowing between $1 million and $2.5 million pay 2.95% based on the latest London interbank offered rate. By contrast, the national average rate for a home-equity line of credit is 5.15% and for a 30-year “private” jumbo mortgage it is 4.08%, according to HSH.com, which tracks the data.

One popular real-estate strategy, according to Anthony D’Andrea, UBS’s head of securities-based lending: Use a stock-based loan to make an all cash bid for a property, then refinance into a traditional mortgage once the deal is closed.

At a time when many potential buyers’ borrowing power is iffy, sellers favor offers they know will close quickly. For those willing to take an extra risk, “it’s an advantage,” says D’Andrea.

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